The risk of higher US inflation prompting faster monetary tightening is a hot topic. New Federal Reserve chair Jay Powell said this week that he is keen to avoid an “overheated economy,” while faster-than-expected wage growth was a key catalyst in February’s stock market correction.
Given the US is about to follow an unprecedented experiment in monetary policy with an unprecedented experiment in fiscal policy, these concerns about the inflation outlook are understandable. But, we see reasons why, at present, the Fed is unlikely to increase the pace of tightening.
- Inflation is only gradually approaching the Fed’s 2% target. The US core personal consumption expenditure (PCE) price index, the Fed’s preferred measure, increased 1.5% year-on-year in January, unchanged from December’s level.
- The Atlanta Fed wage growth tracker is currently 3%, but was as high as 3.9% in November. Also, wage growth may not feed through to inflation. With the US close to full employment, the pace of growth in payroll numbers is likely to slow, while we expect GDP growth to pick up, in part because of fiscal stimulus. Productivity should rise: the consensus forecast for US productivity growth this year is 1.6%, up from 1% in 2017, according to Consensus Economics.
- In his testimony to Congress, Powell reiterated that the Fed’s inflation target is a symmetric objective. Inflation can be both below and above 2% without triggering a change in Fed policy.
We are monitoring developments closely, but currently we believe fears of faster Fed tightening are overdone. We remain overweight US 10-year Treasuries versus cash and overweight global equities.
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